- 2017 has been a great year for Canada, with the economy growing at a very fast pace
- Recent data points suggest that the party may be over, tying the BoC's hands
- The loonie will need another driver, such as rising crude oil prices, to keep rallying from here
As a resource driven economy, Canada is a boom and bust kind of place. In 2017 Canada has been experiencing a world-beating boom, with the economy firing on all cylinders. Consumer, business and government spending is all up this year. Year-over-year growth recently peaked at an amazing 4.7% last May, which was the country’s fastest growth rate since 2000! Since then, growth rates have been falling in rate-of-change terms, with the latest figures from July 2017 showing 3.8% growth.
After two hikes, Bank of Canada changing tack
Following a string of strong growth figures, the Bank of Canada first hiked interest rates last July, as expected. Yet the Bank also managed surprised the market with its intention to return to ‘normal’ monetary conditions. Markets quickly priced in additional rate hikes, and the loonie strengthened as a result. In September, the BoC surprised again by hiking without telegraphing its intentions beforehand, once again leading to strength in the Canadian dollar. Looking at how speculators are positioned in futures markets, Canadian dollar positions are now almost two standard deviations above their historical 1-year average. This is shown below:
Long CAD positions remain crowded
The bigger question is what happens to the Canadian dollar in Q3 2017 and beyond. As all economies grow in cycles, recent data suggests that growth has peaked. Given Deputy Governor Leduc’s recent comments, the BoC can see this coming as well. A historical perspective of Canadian growth and inflation is illustrated below:
Economy to continue rolling over, with inflation still below target
Our view is that economic growth is likely to continue decelerating over the coming four quarters, given that the Canadian economy cannot sustain today’s growth rates indefinitely. We expect to see many more headlines relating to the housing slowdown (particularly in Toronto) and problems relating to consumer debt that remains at historically elevated levels.
Furthermore, the combination of a decelerating economy and subdued inflation is likely to tie the BoC's hands in the future, and force the Bank to shift monetary policy to neutral. The implication for the loonie is that while the good times can continue for another quarter or two, expect the currency to fall victim to economic trends in the near future. Once the economic picture changes, the loonie will need new drivers such as higher crude oil prices to strengthen.